10 Biggest Tax Mistakes Small Businesses Make

Afraid of making tax mistakes that could get you in trouble with Uncle Sam? Here are 10 easy missteps to avoid.

With your focus on customer acquisition and sales, taxes often take a backseat for your time and attention. But during tax season, don’t be so distracted that you make mistakes which can result in overpaying your taxes, triggering tax penalties or virtually inviting an audit.

To help you navigate the minefield of small-business taxes, here’s a list of 10 common errors you should avoid:

1. Failing to report information as it’s reported to you. IRS computers match the information reported on 1099s to the entries on taxpayers’ returns. Income reported on a Form 1099-MISC should be reported on your return in the same way, even if you need to make adjustments. For instance, let's say you received income from a vendor in January 2014 that the vendor reported as income it paid to you in December 2013. If you use the cash basis of accounting, you don't have to include it as income for 2013, so you make an adjustment on your return..

2. Filing certain forms and schedules. Some of these are actually invitations to be audited. For example, if you start a business and want to keep the IRS from challenging it as a hobby activity for which losses will be disallowed, you can file Form 5213. This prevents the IRS from auditing you for five years in most cases. But at the end of this period, the IRS will likely review your returns for these years to see whether you’ve met the presumption for a profit motive (being profitable in three out of five years). Think very carefully before you file any form.

3. Failing to properly apply limitations. For example, only 50 percent of meal and entertainment costs are deductible—be sure not to deduct more than that. And startup costs over $5,000 must be amortized and can't be written off in full in the first year of business.

4. Not keeping good records. You need thorough and accurate records so you can properly prepare your returns—without them, you may overlook legitimate write-offs. Perhaps even worse, you may lose the deductions you’ve taken if you're audited and don’t have the records needed to prove entitlement to the deductions. Save receipts, invoices and other papers that show income and expenses. Use a good accounting tool—software or in the cloud—to record your income and expenses.

5. Overreporting income. If you sell goods on which you collect sales tax, your reportable income should not include the sales tax. Be sure to subtract the sales tax before reporting the income from the sales.

6. Forgetting carryovers. Certain unused deductions and credits may be carried over and used in a future year. For example, if you couldn’t take the full home office deduction last year because your income was too low, you're allowed a carryover that can be used this year. Some other carryovers: capital losses, net operating losses and general business credits.

7. Not claiming the home office deduction. If your home is also where you run your business, don’t fail to take a deduction for it. Some people believe this deduction is a red flag for auditors, but now that 52 percent of all businesses in the U.S. are run from home, it’s not likely that this audit fear is real. And now there are two ways to write off home office expenses, provided you meet the requirements for a home office deduction: deducting your actual expenses or an IRS-set simplified rate.

8. Misclassifying workers. Make sure the workers you pay as independent contractors aren’t really employees. This hot audit issue can result in significant payroll tax penalties if you’re wrong. Understand the IRS tax rules for worker classification, which you can find here.

9. Not filing on time. When owners forget about tax deadlines or don’t have the cash on hand to pay their taxes, they may fail to file a tax return. This results in a failure-to-file penalty that accrues until a return is filed. If you’re too busy to file by the usual deadline, instead of doing nothing, ask for a filing extension (Form 4868 for sole proprietors; Form 7004 for all other businesses). Don’t let your inability to pay what’s owed delay the filing of your return. Pay what you can, and use an installment payment agreement for the rest. Details about installment payments can be found here.

10. Using the wrong tax professional. Don’t use anyone who suggests that you hide income or take write-offs you know you aren’t entitled to—this is a tip-off that the preparer is shady. If the IRS catches the preparer, all the preparer’s clients may come under audit. And, by not using a good preparer, you may miss out on write-offs you're rightfully entitled to.

Give taxes the time and attention they deserve so you can pay as little as you’re legally required to pay. And you’ll sleep well at night!

Barbara Weltman is an attorney and author of J.K. Lasser’s Small Business Taxes and J.K. Lasser’s Guide to Self-Employment. She is also the publisher of Idea of the Day® and monthly e-newsletterBig Ideas for Small Business® at www.barbaraweltman.com and host of Build Your Business radio. She has been named one of the 100 Small Business Influencers three years in a row. Follow her on Twitter @BarbaraWeltman.